FED HOLDS LINE; OPTIMISM HOLDS SWAY

In a decision that surprised many, Federal Reserve officials voted Tuesday against raising key interest rates, as anti-inflation hard-liners failed to convince colleagues that higher rates were needed to dampen the economy and prevent inflation.

The inaction came at one of the most controversial and widely watched Fed meetings in years.

It followed by one week a leak to Reuters news service that eight of the 12 presidents of the Fed's regional banks wanted higher rates, a breach that the FBI is investigating.

Although some experts said the Fed's decision was justified by economic factors, others disagreed. Indeed, some Fed-watchers accused the central bank of being driven more by politics than economics: Tuesday's meeting was the last one scheduled for the Fed policy group before the Nov. 5 election.

"The only possible reason that we can imagine, that at this point in time they could be looking at this (evidence of a strong economy that could spark inflation) and throwing it away, is politics, politics, politics, politics," said Robert Brusca, chief economist of Nikko Securities Co. International in New York.

David Hale, chief economist at Zurich Kemper Investments in Chicago, said: "There's a significant possibility there'll be a Democratic Congress, not just the White House.

"You've got several possible Democratic members who'll be in committee chairmanships who could do some damage" to the Fed, he said.

The Fed has come under fire from Democrats recently not just for its monetary policies but also its management practices. Several Democratic senators have said the Fed has kept interest rates too high, sacrificing job growth, in an overzealous fight against inflation.

President Clinton, campaigning in New Jersey, welcomed the Fed's decision: "I just think it shows we've got a strong economy with no inflation. I'm happy about that."

The president stands to benefit from the Fed's inaction. A rate hike would have had little discernible effect on the economy's momentum before the general election six weeks from now. But it probably would have begun to slow the economy after the start of a second Clinton term, an unwelcome prospect even for a lame-duck president.

Suspicions about the Fed's motivations are nearly impossible to prove. Fed officials, of course, would vehemently deny ulterior motives, though history also suggests they are wary of raising rates during an election campaign. But for such speculation to be making the rounds in financial markets could spell future trouble.

Investors have, until now, trusted the Fed under Chairman Alan Greenspan to keep a tight lid on inflation. Any significant erosion of that trust could lead to a downturn in financial markets.

"It's just not the kind of signal you want the central bank to send," Brusca said.

Whether such criticism is fair is another matter. Many economists had said before the meeting that any decision would be a close call, because the economy was sending off so many conflicting signals of robustness and weakening.

The financial markets reacted ambivalently to the decision. After rallying immediately following the announcement, the Dow Jones industrial average fell 20.71 points, closing at 5874.03.

The bond market, however, ended trading with a rally. The yield on the benchmark 30-year Treasury bond fell to 6.98 percent, from 7.02 percent late Monday.

Many economists had expected the Fed to raise the federal funds rate, the rate that banks charge each other for overnight loans, by at least .25 percentage point from the current 5.25 percent. Changes by the Fed in the rate usually ripple through the economy, affecting business and consumer loans.

The Fed, as is customary, did not reveal details of its gathering, leaving the world to wait until it releases the meeting's minutes in several weeks.

But Fed-watchers suspect Tuesday's meeting was livelier than usual because of last week's leak. Some thought the leak was meant to pressure Greenspan and the other members of the Federal Open Market Committee to raise rates.

"I'm pretty sure it was a contentious meeting, there's little question about that," said John Lonski, chief economist for Moody's Investors Service in New York.

Lonski, like many other economists, said he believes the Fed's decision hinged on economic, not political, motives. He said drooping retail sales gave the Fed confidence it could afford to wait before orchestrating any increase in short-term rates.

"The Fed wishes to better assess what has become of consumer spending before taking action that is likely to further slow consumer spending," Lonski said.

Some economists also said the Fed's decision confirms their own belief that inflation remains tame.

"I don't see any inflationary pressures," said Joseph Stiglitz, chairman of the White House's Council of Economic Advisors. "Not only are prices not going up, but real wages are going up but at a rate less than productivity, so that there's no pressure for increasing prices."

In any event, Hale said, in coming weeks the financial markets will be looking for the Fed to raise interest rates if additional economic statistics point to a still strong economy.

"If we get a very strong employment release in the next two weeks and they tighten then, there's no credibility problem," Hale said.

"But if we go through October with very strong numbers that call into question what they did, and there's no response, then you have credibility problems. There's still a second chance. But the clock is ticking."